Financial crises are likely to be followed by hard-right reactions

by Manuel Funke, Moritz Schularick, Christoph Trebesch

Manuel Funke is a Doctoral Candidate in Economics and Social Science at the Graduate School of North American Studies, John F. Kennedy Institute for North American Studies at the Free University Berlin. Moritz Schularick is Professor of Economics at the University of Bonn and a Research Fellow of the Centre for Economic Policy Research. Christoph Trebesch is an Assistant Professor of Economics at the University of Munich and a Research Affiliate of CEPR, CESifo and the Kiel Institute for the World Economy.

SUMMARY: Recent events in Europe provide ample evidence that the political aftershocks of financial crises can be severe. This column uses a new dataset that covers elections and crises in 20 advanced economies going back to 1870 to systematically study the political aftermath of financial crises. Far-right parties are the biggest beneficiaries of financial crises, while the fractionalisation of parliaments complicates post-crisis governance. These effects are not observed following normal recessions or severe non-financial macroeconomic shocks.

The Crisis has dealt a severe blow to Europe’s political system. Rushing from one emergency summit to the next, crisis fighting has become the new normal for Europe’s political class. At the national level too, two-party systems that were stable for decades have been swept away in recent years, with new parties seeing landslide victories in elections. Mass demonstrations, strikes and political turmoil make daily headlines.

With the catastrophe of the 1930s in mind, the fear of ongoing political radicalisation in the wake of economic and financial disasters looms large in the public discourse. What does history have to say about the political after-effects of financial crises in modern democracies? Can we, over the long run of modern history, identify systematic shifts in the political landscape after financial crises?

We are not the first to ask such questions. De Bromhead et al (2012) show how the Great Depression in the 1930s triggered political extremism. Using more recent data, Grüner and Brückner (2010) find that low growth is associated with more extremist voting, while Mian et al (2012) find that financial crises are followed by fractionalisation and polarisation of parliaments. Related, Bloom et al (2011) demonstrate that policy uncertainty is particularly high after financial crises.

In a new paper (Funke et al 2015), we conduct the most comprehensive historical analysis on the political fall-out of financial crises to date. We trace the political history of 20 advanced democracies back to the 1870s and construct a dataset of more than 800 elections from 1870 to 2014. We then complement this dataset with existing data on more than 100 financial crises and with historical data on street protests (demonstrations, riots, and strikes).

Increasing polarisation: Hard right turns

Our first main finding is that politics takes a hard right turn following financial crises. On average, far-right votes increase by about a third in the five years following systemic banking distress, as shown in Figure 1. This pattern is visible in the data both before and after WWII and is robust when controlling for economic conditions and different voting systems. The gains of extreme right-wing parties were particularly pronounced after the global crises of the 1920s/1930s and after 2008. However, we also find similar patterns after regional financial crises, such as the Scandinavian banking crises of the early 1990s. Moreover, we identify an important asymmetry in the political response to crises – on average, the far left did not profit equally from episodes of financial instability.

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